New rules to break open pension pots

THE government have introduced new flexibility for pension savers with small pension pots, allowing them to take their fund as a one-off lump sum rather than having to buy an income with it.

HM Revenue & Customs estimates that this will affect around 25,000 people who are aged over 60, who have total pension rights in excess of £18,000 and who have an individual pension pot worth less than £2,000.

However, it remains unclear why the government decided to allow commutation of small pension pots from age 60. People can generally crystallise pension benefits from age 55, so why the five year difference?

Step in right direction

Nevertheless, the pensions crisis will only get worse if the government doesn’t take positive action, so this move is a step in the right direction.

Thousands of small pension pots exist today, and the forthcoming National Employment Savings Trust is going to create many more small pension pots.

From October 2012, the largest employers in the UK will be forced to auto-enrol all staff aged between 22 and state pension age, and paid at least £7,475 per annum, into a workplace pension scheme.

By October 2016, all British employers will have to do the same. The exact date by which companies must comply will depend on the number of employees and the company’s PAYE reference number, if they have less than 50 employees.

Cash up front

Unfortunately, it’s not economically viable for independent financial advisers to advise on small pots, which are also unprofitable for annuity providers.

Against the current economic backdrop, a 65-year-old man, for example, might prefer to have full access to a pension pot of £1,000 – getting cash up front – rather than the income it would buy, of just around £5 a month.

Should you consolidate?

Alternatively, those with a number of small pension pots could think about consolidating them into one bigger pot – and for many people this is a good strategy.

Amalgamating your various pension pots could help you to secure a higher annuity rate, but make sure you don’t consolidate into a higher-charging pension plan: this could wipe out any potential gains.

This strategy could also be fruitful for those are just short of the minimum income requirement, of £20,000 a year, to qualify for new ‘flexible drawdown’ rules, whereby you can take as much income as you want from your pension fund.

Plan long-term

These new rules that allow retirement savers to break open small pension pots are very welcome, but we shouldn’t lose sight of the fact that a pension pot is designed to provide an income in retirement until you die.

Paint a picture of your ideal future and seek advice to devise a plan for that future. The key is planning ahead: as the old adage goes, failing to plan is planning to fail!